By Karen Petrou
- New evidence reinforces monetary policy’s distributional impact.
- Monetary policy can also be redesigned to ensure that its distributional impact enhances equality instead of – as now – making it worse.
- More evidence also reinforces the link between unequal monetary policy and slow growth.
This blog, like my forthcoming book, has shown empirically and analytically in many ways that monetary policy has profound inequality impact no matter how hard central bankers try to shift all the blame to fiscal policy. We have also shown that monetary policy that isn’t inclusive is monetary policy that, like the Fed’s since 2010, does little more than sputter when it comes to sustained growth no matter the huge gains created for the ultra-wealthy. Further evidence for the disequalizing impact of post-crisis policy comes from a recent IMF study. The models on which it depends are, as always, idealized constructs, not the real world. And, some of the study’s assumptions are idiosyncratic. Still, it’s a milestone on the way to monetary policy that is inclusive and thereby also effective.
What the Study Says
We won’t say “what the study shows” because the study is, as noted, model-constructed and thus – as its authors readily admit — dependent on the assumptions built into the tractable Two-Agent New-Keynesian construct and, for good measure, a raft of assumptions also about different approaches to monetary policy. Even so, bear with me.
Within this framework, the paper assesses what it calls “optimal” policy akin in many ways to the Fed’s current approach in that it depends on representative-agent assumptions in which everyone has the same economic resources. Thus, aggregate unemployment is a goal, not employment measured by distributional data of un-, under-, and multiple-employment households along the lines we have long recommended. The Federal Reserve Bank of St. Louis has toyed with its own approach to optimal policy with a distributional bent, but the most recent adaptation of Fed monetary policy is having none of it.
The paper’s second monetary-policy option is a set of variations on the Taylor Rule in which fixed targets – most importantly price stability – drive accommodation or tightening action. Various Taylor options are then constructed and tested.
Overall, the study’s findings are instructive. In the optimal “averaging” approach, policy is most effective as consumption inequality increases if it focuses on growth, not price stability. This is because of the importance of wages to lower-income households. Under the paper’s “augmented” Taylor Rule, lower interest rates also lead to higher wages, thus enhancing growth by avoiding undue near-term tightening even when there is inflation and wage rigidity. In all cases, a focus solely on price stability proves distributionally disastrous.
What We Now Know
Although the Fed is stuck in its representative-agent rut, its new policy is at least an implicit concession to this paper’s conclusions about focusing on growth, not price stability. However, the paper does not prove or even lead one to infer that the Fed’s new, “make-up” policy will do any better distributionally than the Fed’s previously disequalizing policies.
This is for two reasons. First, the IMF staff paper for some reason chooses to judge inequality based on the “consumption gap,” not on income or wealth indicators as is almost always done. Incorporating consumption into a multi-dimensional inequality model has merit, as a Fed staff study demonstrated. But consumption alone is highly misleading – for example, it alone doesn’t tell you if consumption is won by dint of wealth or due to debt.
Secondly, the paper’s models assume a conventional, short-term policy focus, not the decades-long unconventional construct in which we now live. As this blog has shown, lower for longer means poorer forever because the more a low-wealth family tries to save its way into financial security the farther it falls behind.
And, nothing in this paper’s model addresses the Fed’s huge portfolio and its own profoundly bad distributional effects. As we have shown going back to 2018, the bigger the Fed’s portfolio, the better it is for stock prices and the worse for output – i.e., the growth on which the IMF paper rightly says low-wage families depend.
Still, central bankers love models and, if they love this one, they’ll come closer to seeing how distributionally important they are, be less likely to hide behind fiscal policy’s skirts, and otherwise move forward more quickly to the most important conclusion of all: continuing emphasis on price stability, ultra-low rates, and huge central-bank portfolios does not promote sustained growth, does not meaningfully increase low-income wages, and accelerates market price hikes that both increase wealth inequality and stoke financial crises exactly like the one in March, 2020. COVID was this crisis’s spark, but inequality was its fuel.